The International Origins of the Federal Reserve System

The International Origins of the Federal Reserve System

The International Origins of the Federal Reserve System

The International Origins of the Federal Reserve System

Synopsis

The Federal Reserve Act of 1913 created the infrastructure for the modern American payments system. Probing the origins of this benchmark legislation, J. Lawrence Broz finds that international factors were crucial to its conception and passage. Until its passage, the United States had suffered under one of most inefficient payment systems in the world. Serious banking panics erupted frequently, and nominal interest rates fluctuated wildly. Structural and regulatory flaws contributed not only to financial instability at home but also to the virtual absence of the dollar in world trade and payments.

Key institutional features of the Federal Reserve Act addressed both these shortcomings but it was the goal of internationalizing usage of the dollar that motivated social actors to pressure Congress for the improvements. With New York bankers in the forefront, an international coalition lobbied for a system that would reduce internal problems such as recurring panics, and simultaneously allow New York to challenge London's preeminence as the global banking center and encourage bankers to make the dollar a worldwide currency of record. To those who organized the political effort to pass the Act, Broz contends, the creation of the Federal Reserve System was first and foremost a response to international opportunities.

Excerpt

From the Civil War to 1913, the United States suffered under one of the worst banking systems in the world. Major panics occurred about every ten years, and seasonal changes in the demand for credit created liquidity disturbances nearly every autumn. To many observers, the panic of 1907 was the last straw, prompting the rise of one of the great organs of American administrative government: the Federal Reserve System. Founded in 1913 by an act of Congress for the expressed purpose of reducing the propensity for panics, the Fed was given a mandate to provide society with one of its most basic public goods: a sound and efficient payments system. This book is an attempt to explain how American society overcame the collective action dilemmas that normally constrain the production of public goods to inadequate levels. In plain English, it is about how the nation produced one of the cornerstones of good government, in the face of disincentives that should have left few people with sufficient motivation to incur the large costs of institutional change.

I argue that Mancur Olson's familiar "joint products" model (also known as the "by-products" or "selective incentives" model) provides the key to understanding the voluntary collective action behind the Federal Reserve Act. The model postulates that a public good produced jointly with a private good can yield collective action in a large group setting, because the addition of the private good creates the necessary convergence between the individual and the social costs of collective action. In other words, if a person wants to enjoy a private good, and that . . .

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